STATEMENT OFELEANOR HILL

INSPECTOR GENERAL, DEPARTMENT OF DEFENSEBEFORE THE SUBCOMMITTEE ONACQUISITION AND TECHNOLOGY

COMMITTEE ON ARMED SERVICESUNITED STATES SENATE

ON ACQUISITION REFORM

Report Number 98-093 DELIVERED: MARCH 18, 1998

Office of the Inspector GeneralDepartment of Defense

Mr. Chairman and Members of the Subcommittee:

I appreciate the opportunity to appear before you todayto discuss acquisition reform. At the outset, I want toemphasize that the Office of the Inspector General (OIG) hasbeen a strong supporter of acquisition reform. We intend tokeep working diligently to help the Department and Congressidentify barriers to more efficient acquisition practices,design new processes, and evaluate the impact of the changesalready in place.

INDICATIONS OF PROGRESS

Considerable progress has been made in streamlining DoDacquisition processes and there are numerous good newsstories. For example, we recently reported that programmanagers for the Landing Transport Dock 17 Ship Class, theJoint Standoff Weapon System, the Air-to-Air InterceptMissile 9X, and an Air Force special access system hadsuccessfully implemented various acquisition reformprinciples such as compressing development schedules,reducing acquisition costs, and making prudent tradeoffsbetween performance, schedule, and cost. We found many"best practices" in use by program managers who wereincorporating nondevelopmental items into their systems.The use of purchase cards to buy goods under the $2,500micropurchase threshold has grown dramatically and inFY 1997 accounted for 71 percent of all purchases under thethreshold. The expanded use of the card has reduced much ofthe paperwork and costs from using purchase orders andcontracts for the small dollar value acquisitions that makeup 91 percent of the 7.9 million DoD procurementtransactions in FY 1997. We have also noted the excellentleadership provided by the Defense Logistics Agency (DLA) inthe Single Process Initiative, an effort to work withindustry to adopt commercially-used, contractor facility-wide processes instead of the more costly contract-uniquerequirements of the past. I am sure that the second panelcan cite many more examples.

While all of this is "good news" for DoD, there isstill much work to be done in the area of acquisitionreform. As a result, much of our effort at the OIGcontinues to focus on acquisition reform on a variety offronts.

PARTICIPATION IN ACQUISITION REFORM

Over the last 5 years, we have participated on over 100management process action teams, integrated process teams,and working groups that have been the Department’s principalmeans of generating new ideas for reforms and processimprovements across the spectrum of DoD business activities,

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especially acquisition and logistics. We are verysupportive of this approach, which is being applied to awide range of issues such as contract administration,acquisition benchmarking, pilot programs, Government-property in the hands of contractors, and reducing lifecycle costs. At present, we are involved in 57 such groups.The growing level of auditor participation on those teamsillustrates the good professional working relationshipbetween the acquisition and audit communities, as well asgeneral acceptance of the need for our advice to beconsidered during the reengineering of DoD processes, notjust after new processes are already put into place.

LESSONS LEARNED FROM OVERSIGHT

Despite budget reductions, the DoD acquisition programcontinues to be far larger than any other capital investmentprogram in the world. At the end of FY 1997, DoD had 85major Defense acquisition programs valued at over $725billion of which over half had yet to be appropriated. Inaddition, there are many hundred small programs. Likewise,the DoD has the largest information technology budget in theGovernment and spends more than $9 billion a year acquiringinformation technology resources. The complexity and scopeof these efforts, the potentially catastrophic consequencesof any failure to provide reliable and technologicallysuperior weapon systems and information tools to our warfighters, and the poor track record in terms of excessivelylong lead times, insufficient attention to life cycle cost,schedule slippage, cost growth, and high unit costs combineto make both weapon system acquisition and informationtechnology investment high risk areas.

Because of those risks, the Office of Inspector Generalhas historically given high priority to prudent auditcoverage of acquisition programs and functions. Despitedownsizing, we issued about 90 audit reports over the pasttwo and a half years that address acquisition of weapons,other materiel and automated information systems. Likewise,procurement fraud remains the principal workload of theDefense Criminal Investigative Service, the criminalinvestigative arm of this office, which has had between1,600 and 1,800 open fraud cases throughout that period.Today, let me share with you some of the results of our workthat bear on acquisition reform.

SPARE PARTS PRICING

Mr. Chairman, your invitation letter requested that Ispecifically address the continuing work by my officereviewing commercial spare parts pricing issues, and anyagency actions taken to correct deficiencies found duringthose reviews.

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Using commercially available, instead of militarilyunique, materiel wherever reasonably possible makes eminentsense. The acquisition reform thrust toward expanding DoDuse of private sector business practices such as primevendor instead of maintaining huge DoD wholesale supplyinventories is also wise. During the past few years, theDoD has been transitioning into different businessrelationships with spare parts vendors and manufacturers.We have issued several reports that address various facetsof this transition.

In March 1994, we reported that the Service inventorycontrol points often were not transferring essentiallogistics management data to the DLA or, conversely, thereceiving inventory control points were not always using thedata. In retrospect, these indicators were a harbinger ofthe DLA failure to reimplement an Air Force program to breakout certain aircraft spares for procurement, which led tothe unnecessary sole-source procurements discussed furtheron in this statement.

In March 1996, we reported that DoD needed to address avariety of issues to successfully implement its initiativesto increase the use of local purchase authority and focusthe role of the central supply system on managing itemswhere value is added. The audit was unable to determine theoverall extent of local procurement of centrally manageditems. However, procurement data provided by 13organizations visited during the audit showed that only$7.2 million of $744 million (less than 1 percent) of thelocal procurements were for centrally managed items.

The report recommended that the Deputy Under Secretaryof Defense (Logistics) develop procedures to haverequisitioning organizations make greater use of localpurchase authority for centrally managed items when localprocurement is in the best interests of the Government;direct that requisitioning organizations develop proceduresto determine the total cost of a local procurement; developa detailed strategy to address the impact of the localpurchase initiatives on centralized material management; anddevelop procedures addressing local procurement wheninventory control points have excess stocks, reporting andrecording of demand data for local procurements, andfeedback on the progress and economies of local purchaseinitiatives. Management indicated that the audit resultswere already being put to use, concurred with the intent ofall recommendations, and proposed alternate methods toencourage greater use of local procurement authority insteadof requisitioning items from central inventory stock.Changing the mindset of personnel in the field so that theyfully utilize their expanded authority and capability tomake their own buying decisions has proven to be anevolutionary process, not an instant fix.

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HOTLINE COMPLAINTS ON SPARE PARTS PRICING

In mid-1996, we received a complaint that the DLA waspaying a major aerospace contractor’s catalog prices, whichwere far higher than prices paid by the DoD for the sameaircraft spare parts before DLA began procuring the parts ina commercial pricing environment. Shortly thereafter, theHotline also received similar allegations concerning DLAprocurements from a second contractor’s parts catalog. Weinitiated audits to determine the validity of theallegations. I emphasize that, having been closely involvedin DoD acquisition reform and infrastructure streamliningefforts, we went into both audits with the full realizationthat some price increases were to be expected in cases wherethe DoD was shifting certain costs to the contractors inorder to obtain such benefits as direct vendor delivery andreduced Government inventory management burdens.

We issued two final audit reports, both currentlyreleasable only inside the Government because they containcontractor confidential or proprietary data, on February 6and March 11, 1998. In brief, both audits substantiated theHotline allegations. We found a range of weaknesses in theDoD approach to purchasing both commercial and non-commercial spare parts, although the specific problems weresomewhat different in the two cases. It is especiallyimportant to emphasize that all of the audited transactionsinvolved were sole-source procurements.

Specifically, we audited the following:

• 278 of 300 delivery orders over $25,000 fromthree DLA centers on one contract duringcalendar years 1994 through 1996.Documentation on the remaining 22 orders couldnot be found for various reasons. The ordersreviewed constituted $22.7 million of the $24.4million in orders placed with that contractorfor aircraft spares like pistons, gearshifts,gears, bearings, bolts, and springs. About$6.1 million was for commercial catalog itemsand the balance for non-commercial items.

• 179 delivery orders totaling $12 million from

DLA to another contractor on three contractsduring the same period. Of the 179 ordersreviewed, 124 orders were purchased from thecontractor’s commercial catalog, and 86 orderswere for items with previous DoD competitiveprice history. The purchased items includedstructural panels, fittings, supports, washers,bolts, and nuts for a wide variety of aircraft.

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AUDIT RESULTS The audits indicated that the contractors involved werenot violating any laws or regulations. However, the DoDprocurement approaches were poorly conceived, badlycoordinated and did not result in the Government gettinggood value for the prices paid for both commercial and non-commercial items. Based on our analysis of previous DoDpurchases of the same aircraft spares, DLA paid prices thatwere considerably higher than a prudent buyer would considerfair and reasonable. Specifically:

• On one contract, DLA paid modestly discountedcatalog prices that were $4.5 million, anaverage of 280 percent per item, more than fairand reasonable prices for $6.1 million ofcommercial items.

• On the same contract, DLA paid $1 million

(FY 1997 dollars), an average of 30 percent,more than fair and reasonable prices fornon-commercial items.

• On three contracts with another supplier, DLA

paid $3.2 million, an average of 171 percent,more than fair and reasonable prices for$5.0 million (FY 1997 dollars) of mixedcommercial and non-commercial parts withprevious DoD price history.

Examples of particularly high price increases include thefollowing:

• DLA paid $714.00 each for 108 electrical bells,a 1,430 percent increase over the previousprice of $46.68.

• DLA paid $1.24 each for 31,108 springs, a 2,380percent increase over the previous price of$.05.

• DLA paid $403.49 each for 246 actuator sleeves,a 1,532 percent increase over the previousprice of $24.72.

• DLA paid $75.60 each for 187 setscrews, a

13,163 percent increase over the previous priceof $.57.

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FLAWS IN DoD PROCUREMENT APPROACH We found considerable evidence that the DoD had not yetlearned how to be an astute buyer in the commercial marketplace. Probably the most fundamental problem, however, wasthat the Government should not have been procuring many ofthese parts on a sole-source basis in the first place,whether they were commercial or non-commercial items. Inthe case of the one contractor, a Military Department hadnegotiated an agreement over 20 years ago that allowed DoDaccess to the contractor’s technical data for thecompetitive procurement of replenishment spare parts. Whenmanagement of those parts was transferred to DLA as part ofthe mass transfer of consumable items over the past fewyears, DLA failed to continue the breakout program. All 179of the orders that we reviewed for one contractor wereeither covered by a previous access to technical dataagreement (159 items) or eligible for competitiveprocurements because the Government owned the technical data(20 items). Similarly, there was little effort until ouraudit to screen the items being bought sole-source from theother contractor to determine whether alternatives likereverse engineering would be cost-effective to enablecompetitive buys. Even in a sole-source situation, it is acceptedcommercial practice for major customers to seek, and oftenobtain, significant discounts off suppliers’ catalog prices.The DLA failed to maximize its negotiating leverage in anymeaningful fashion and therefore received only modestdiscounts from one contractor and none from the other. Bothof our reports contain data illustrating that the DoD was byfar the largest customer for most of the parts in question.In some cases, DoD was the only purchaser of the part evenif it was a commercial item. (Under FAR 2.101, any item"offered for sale, lease or license to the general public"is termed a commercial item.) The potential DoD influenceas a major customer was diminished, however, by acombination of an extremely disjointed procurement approachand a widespread misimpression that aggressively pursuingdiscounts was either unnecessary or not in consonance withcommercial practices. It is telling, we believe, that DLA used at least 75different contracting officers to negotiate and award about1,800 individual orders with one of these contractors. These contracting officers operated in isolation, asreflected in their completely different perceptions of thereasonableness of the contractor’s prices. While someaccepted any "commercial price" as a good price, othersunsuccessfully sought uncertified cost or pricing data. Another problem involved the misperception that DoD was

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somehow getting good value despite the drastic per unitprice markup. For example, buying from a commercial partscatalog generally enables the buyer to eliminate in-houseinventory storage and distribution operations. Thecommercial supplier offers timely direct vendor delivery andthe commercial price structure reflects that the supplier iscarrying that burden. In the case of the orders that we audited, DLA wasgenerally buying for inventory and therefore the "directdelivery" was to a Government warehouse, not a user of theparts. Therefore, there was no apparent discomfort with thefact that neither contractor’s delivery response time wasparticularly good. Other problems included using a basic orderingagreement instead of a better contract vehicle, not groupingpurchases for inventory into economic order quantities,negotiating prices based on small quantity purchases despitethe fact that overall requirements were rather large andinadequate requirements forecasting. We also found littlejustification for having DLA be the purchasing agent formany of the small orders, which resulted in DoD customershaving to pay a large DLA surcharge with minimal valueadded. Local procurement is a viable option when buyingsmall quantities for immediate use, since commercial partscatalogs are readily accessible through electronic media. A final problem, which surfaced in the managementcomments on the draft version of our February 1998 report,is the lack of good management information on the overallexperience to date in buying commercial items. DLAestimated that prices for commercial items, on contractsover $25,000 awarded under FAR Part 12, had modestlydecreased. Unfortunately, their study was completelyunsupportable. The DLA and we agree that the database usedfor the study is badly flawed with numerous coding errors.Moreover, we found major problems with the methodology.Although we share the frustration caused by not having thefull picture on the impact of buying commercial items, sofar we have not been shown or found data from which overallconclusions can be reliably developed. DoD CORRECTIVE ACTIONS I am pleased to be able to report to you that DoDsenior managers in both DLA and the Office of the UnderSecretary of Defense for Acquisition and Technologyrecognized the importance of our findings right away andtook appropriate actions. There had been some disagreementwith our position that contracting officers should be awareof and empowered to obtain uncertified cost or pricing data,if in their best judgment, it is necessary to understand thebasis of a commercial price. We remain convinced that

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access to such data often is particularly important indetermining price reasonableness of sole-source items where,as in this case, there is no competitive commercial marketto ensure the integrity of prices. We have not yet receivedfinal comments on our February 6 and March 11 reports, so Ido not know if this or any other substantive issues remainunresolved at this point. In December 1997, a new indefinite-delivery corporatecontract was awarded to one contractor for 216 sole-sourcecommercial items which will save, according to DLA, about$83.8 million over a 6-year period. The negotiations whichbegan in October 1997, were difficult and were conducted inan environment where obtaining even uncertified cost orpricing data is strongly discouraged. On November 5, 1997, we sent a memorandum to DLAexpressing concern that the negotiating team had notrequested uncertified cost or pricing data from thecontractor. On November 7, 1997, the contracting officerwrote the contractor requesting uncertified cost or pricingdata for 73 items where the negotiating team had been unableto support the prices as fair and reasonable. Only three days later the contractor accepted theGovernment's last (and fourth) offer instead of providingthe cost data. Prior to the request for cost data, thecontractor's last offer was still 21.4% higher than thefinal Government offer. While the final negotiated pricewas clearly more reasonable than the last contractor offer,it is still higher than the Government's prenegotiationmaximum position. We can only speculate as to the impact,if any, of the request for cost data on the contractor'sdecision to accept a price that had clearly beenunacceptable up to that point. In any event, DoDunderstanding of the basis for the contractor's pricingremains incomplete and any analysis of the reasonableness ofthe agreement must necessarily be somewhat subjective. Generally, however, we agree with the Department’soverall approach of using the lessons learned from our workand possibly other sources to develop more effectivetraining for DoD personnel on being smart buyers in the newacquisition environment. We also welcome the offer byindustry associations to help arrange more dialogue betweenGovernment and industry procurement experts to helpfacilitate new business relationships in which both sides’interests are protected. This cooperation will be helpfulto DoD in terms of both training and policy initiatives.

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The agreed-upon DoD actions also include:

• Negotiating and awarding a new indefinite-delivery contract with one contractor thatprovides more substantial discounts off catalogprices;

• Seeking a similar up-front pricing arrangement

for non-commercial items; • Requesting voluntary refunds where appropriate; • Rectifying the problems found with sole-source

procurements in the situation where drawingswere available, but not being used to solicititems competitively;

• Considering alternatives to the other

sole-source situations addressed by theauditors;

• Reviewing whether the audited corporate

contract is now being used properly; • Using the DLA Method of Support Model or other

business case analysis model suitable forplanning major changes from stock management,before shifting to commercial businesspractices, such as a corporate contract;

• Training DLA managers and operations personnel

in the proper use of corporate contracts, itemsand requirements that should be excluded, datarequests and evaluations of prices. DLA issuedspecific guidance in a policy letter,"Determinations of Commerciality and PriceReasonableness," dated June 10, 1997;

• Developing automated system changes to preclude

automatic order placement for:

(a) first time buys, to assure items are procured competitively; (This will establish a substantiated cost baseline for subsequent comparisons, e.g., comparing competitive prices to corporate contract price lists.) (b) subsequent requisitions for stock- numbered items for which the buy history indicates continued use of a corporate contract would likely result in a

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substantially higher material cost and/or an unacceptable delivery timeframe;

• Continuing to make a concerted effort todevelop long-term stable partnerships withcompetitive, as well as sole-source suppliersavailable on DLA’s electronic shipping mall toenable their customers to select the mostadvantageous source to meet their needs.

While we consider DoD actions to be responsive to theconcerns raised in our report, additional measures may beneeded as more is learned about both pitfalls and bestpractices related to buying commercial products. We arecurrently auditing a third DLA corporate contractarrangement and the General Accounting Office has beenconducting reviews that will provide more data. Finally,while we hope our audit work will continue to be helpful inthis area, we encourage more self-evaluation by the DoDacquisition community.

FUNDING INSTABILITY

Despite the important issues at hand regarding DoDbuying practices for supplies and spare parts, a strong casecan be made that pervasive funding instability is theDepartment’s single most challenging acquisition reformissue. Instability in the execution of acquisition programsis the leading cause of cost growth and schedule slips inmajor weapon systems. In order not to degrade readiness,the DoD has often used weapon system acquisition programs asbill payers for unbudgeted operational and contingencycosts. Moreover, neither acquisition planning nor supportprogram budgets always conform to fiscal reality. Theimpression of too many programs chasing too few dollars hasbeen a DoD acquisition issue for many years, and it isdifficult to make a convincing case that the tendency toover-program has been overcome. Affordability-inducedprogram changes and production rate cut backs in mid-streamresult in a vicious cycle of increased costs that can causefurther reductions in quantities, additional stretch-outs,and even greater per unit costs. The DoD estimates thatevery dollar removed from a program in the near yearsrequires three dollars in later years to make up thereduction.

This is definitely an area where dialogue andpartnership between the DoD and Congress are needed. Therecan never be enough emphasis on improving weapon systemacquisition and life cycle cost estimating, as well as onrealistic programming and budgeting in all DoD accounts. Wealso need to respond more effectively to program managers’

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assertions (as expressed in numerous process action teamsand other forums) that funds are constantly siphoned offeven during budget execution. We recently initiated anaudit to shed more light on to what extent this is occurringand why.

Program management flexibility is also severelyconstrained by the way in which funds are appropriated andallocated in a myriad of separate accounts. The DoDaccounting systems were designed to meet the need tomaintain the integrity of each of the tens of thousands ofaccounts maintained by the DoD in what is undoubtedly themost complicated chart of accounts in the world. Thismultiplicity of "colors of money" is a root cause of theformidable DoD problems with the accuracy of accountingdata, the complexity of our contracts, the difficulty ofproperly managing disbursements and progress payments, thehigh overhead costs of DoD budget and accounting operations,and the considerable restrictions on the flexibility ofmanagers to shift funds quickly to meet contingencies. Eachcontractor voucher must contain at least one, and in somecases, many accounting classification codes that typicallyhave from 46 to 55 characters a piece. This is in contrast,of course, to the 16 characters used for a commercial creditcard account.

We believe that the DoD and Congress ought toreconsider the need for so many discrete appropriations andsubaccounts, as well as the adequacy of the currentlyauthorized periods of obligational availability ofappropriations. These kinds of issues are seldom consideredin the context of acquisition reform, but we believe thatany streamlining of DoD financial management requirementswould considerably assist acquisition managers.

JOINT CONTRACTING FOR DEPOT MAINTENANCE OF SECONDARY ITEMS

Based on audits conducted recently, we are confidentthat there are numerous additional opportunities foracquisition reform.

For example, we recently reported that the MilitaryDepartments are not identifying opportunities and initiatingactions for joint contracts for repair of secondary items.Taking a snapshot at a point in time in FY 1997, weidentified over 3,000 open contracts, valued at over $1billion, that involved multiple inventory control points ofthe Military Departments using the same repair facility orsupplier, which were candidates for joint contracting. Wenoted that individual contractor repair facilities had 10,50, or even as many as 110 different open repair contractsfrom the various DoD inventory control points.

There are significant opportunities for administrative

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efficiencies and economies-of-scale cost savings from jointcontracting. At a facility with multiple open contracts,the contractor and DoD would both benefit from having oneomnibus type of contract covering all REPAIR actions for agiven period of time. The inventory control points of eachof the Military Departments are focusing on their ownrequirements, but do not have the criteria or processes inplace for combining DoD-wide requirements on a singlecontract for depot maintenance of repairable items. Becausethis issue cuts across the logistics and acquisitionbureaucracies of the Military Departments, there may beinstitutional resistance. However, this is another instancewhere we think the DoD must reorganize its acquisitionapproach, simply to be a smarter buyer of services.

DUAL MANAGEMENT OF COMMERCIALLY-AVAILABLE COMMODITIES

We are reviewing the issue of dual management ofcommercially available commodities. The General ServicesAdministration (GSA) has expanded the range of commercialproducts available through its Federal Supply Schedule.With the expansion of GSA products that were offered toGovernment organizations, there is justifiable concern thatDoD is operating central procurement programs for the sameproducts as GSA, tying up scarce DoD acquisition workforceresources that are needed elsewhere.

We are now performing an audit addressing the DLAinitiatives to procure commercial brand name items and theDLA management of selected commodities. Our work to datesuggests that the DLA has duplicated and competed withprocurement and supply programs of other Governmentorganizations in procuring commercial brand name items. Itis our belief that, in this era of dwindling DoD resources,the DLA should concentrate on its role as a combat supportagency and direct its efforts toward procuring replenishmentparts for essential weapon systems, or personnel items thatare in support of military operations. By competing withother Government organizations for commercial products, theDLA and its DoD customers are missing opportunities toconsolidate purchases under a single source of supply. Inconsolidating purchases, DoD increases its potential forsignificant savings due to volume buying discounts whilecutting administrative costs.

In a report on the DLA Electronic Catalog PilotProgram, we commended DLA for starting an electronic catalogto reduce reliance on DoD inventories. However, we notedthat many products in the catalog duplicated productsoffered by GSA programs, particularly the GSA Advantagesystem. The Advantage system is a shopping service on theInternet that gives customers access to approximately310,000 items, and when it is completed in July 1998, theAdvantage system is expected to contain approximately

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4 million items. Of the seven vendors in the DLA pilotprogram, five vendors, or companies supplying items to thevendors, had contracts with the GSA for the same or similaritems. The types of items that the vendors suppliedincluded cleaning supplies, office equipment and supplies,packaging materiel, and storage cabinets. We also foundthat the DLA electronic catalog prices were higher than GSAprices. The higher prices were partly caused by thedifference in the cost recovery factors used by bothorganizations to recoup costs for administering theirprograms. The DLA cost recovery factor was 7.6 percent ofthe cost of the products while the GSA factor for FederalSupply Schedule contracts was 1 percent. We are workingwith DLA to resolve our concerns over the duplication incommercial products offered by DLA and GSA in the electroniccatalog by surveying the preferences of the potential DoDcustomers, principally in the Military Departments.

We also recently reported that the DLA managed battery,food service, and photographic national stock numbered itemsin 17 Federal supply classes that were centrally procured bythe GSA. The items included commercial products such as adeep fat fryer, dishwasher, film, and an ice cream cabinet.Our random statistical sample indicated that 27,958(61 percent) of 45,936 national stock numbered items wereeither procured by the GSA, or the DLA and the GSAcontracted with the same vendors. Additionally, ouranalysis of the 17 Federal supply classes showed thatapproximately 92 percent of the items managed in theseclasses were classified as nonessential to the operations ofmilitary weapon systems.

We also found that in some instances DLA customers paidhigher prices than if the same item were procured throughthe GSA. For example, The Defense Supply Center Richmond,Virginia, using a GSA Federal Supply Schedule, placed adelivery order with a vendor for color print film. Thevendor shipped the film directly to the DoD customer and thesupply center was billed $34,842 for the film. The SupplyCenter added a 45-percent cost recovery factor to the SupplySchedule contract price and billed the customer $50,572,which was $15,730 more than the GSA price. While attemptingto resolve this issue with DLA, we learned that the DLA wasplanning to expand its procurement of commercial items byestablishing a prime vendor program for food serviceequipment which will further duplicate items GSA sells.

We are also auditing apparent DLA duplication with theDepartment of Veterans Affairs in the purchase ofcommercially available medical items for medical treatmentfacilities. DLA spent about $46 million during FY 1997 toestablish prices and engage medical contractors primarily tofill customer orders, valued at about $1 billion, from DoDmedical treatment facilities. Likewise, we are auditing a

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similar situation involving DLA, GSA, and the NationalIndustries of the Blind regarding office supplies.

In general, we believe that the DoD should stopcompeting with other Government Agencies that have themission to buy and supply commercial items, both to conserveDoD acquisition resources and to avoid reducing overallGovernment negotiating leverage with suppliers. We havebrought our audit results in this area to the attention ofsenior managers and are continuing to work this issue withinthe Department.

ADVANCED CONCEPT TECHNOLOGY DEMONSTRATION PROGRAM

The Advanced Concept Technology Demonstration (ACTD)Program is an important acquisition reform initiative to getemerging new technologies to meet critical military needs tothe war fighters in a much shorter time than the "normal"acquisition development cycle. The Department used 10selection criteria established in November 1995 to chooseprograms for inclusion in the ACTD initiative. Thosecriteria included requirements that the technology should besufficiently mature and the proposed program should providesignificantly increased military capability. DoDacquisition regulations also stated that ACTD projectsshould meet urgent military needs. When we reviewed theprogram, the DoD had approved 22 projects, valued at$4 billion, in FYs 1995 and 1996. We found that support forthe program was hampered because there was no clearunderstanding among the technologists and the war fightersof what is a critical military need and what is a maturetechnology. We reported that, based on the then currentselection criteria, five projects, valued at $2.3 billion,appeared to be questionable selections for this program. Asa result, the Joint Staff and the Office of the UnderSecretary of Defense for Acquisition and Technology agreedto clarify the criteria used to select projects for thisprogram. Draft revised criteria now have been circulatedwithin the Department for comment. When they are finalized,those criteria will be included in the Acquisition Deskbook.

OTHER TRANSACTIONS

The use of "other transactions" is authorized under10 U.S.C. 2371 as a way to encourage commercial firms tojoin with the Department in the advancement of dual-usetechnology, contribute to a broadening of the technology andindustrial base available to the Department, and fosterwithin the technology and industrial base new relations andpractices that support national security. An "othertransaction" is not a contract, grant or cooperativeagreement. "Other transactions" are considered exempt fromthe Competition in Contracting Act, Truth-in-NegotiationsAct, Contract Disputes Act, Antikickback Act of 1986,

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Procurement Integrity Act, Service Contract Act, BuyAmerican Act, the intellectual property clauses of the Bayh-Dole Act, the Title 10 sections relating to procurementcontracts and the Federal Acquisition Regulation. "Othertransactions" are also exempt from audit access forexamination of contractor records by the General AccountingOffice and Defense Contract Audit Agency.

There are two types of "other transactions" authorizedby law. The first type of "other transaction" wasauthorized in 1989 to enable the Defense Advanced ResearchProjects Agency, and the rest of DoD in 1991, to accesscommercial technology for research and development purposes.I will refer to these as research "other transactions."Research "other transactions" usually consist of aconsortium of companies and requires the companies tocontribute at least 50 percent of the costs, to the extentpracticable. The Department can waive the 50 percent costshare. There is also a requirement that there be adetermination that a contract, grant or cooperativeagreement would not be feasible or appropriate. The secondtype of "other transaction" was authorized in Section 845 ofPublic Law 103-160 and authorized the Defense AdvanceResearch Projects Agency in 1994, and the rest of theDepartment in 1996, to enter into "other transactions" forprototype projects related to weapons or weapon systems. Iwill refer to these as prototype "other transactions."Prototype "other transactions" do not require cost sharingor the determination that a contract, grant or cooperativeagreement would not be feasible or appropriate.

The basic authority for "other transactions in10 U.S.C. 2371 requires the Secretary of Defense to issueregulations but none have been published. Although therehave been reviews by the Department and the American BarAssociation on what statutes are not applicable to "othertransactions," there is no definitive list published.

For FY 1990 through FY 1997, we believe the Departmentissued 171 research "other transactions," valued at$3 billion, and 59 prototypes "other transactions", valuedat $837 million. We have had continuing concerns about alack of controls over the "other transactions" process sincenone of the normal rules and procedures apparently apply.In our 1997 report on 28 "other transactions" awarded by theDefense Advanced Research Projects Agency, we outlined theneed to put funds advanced to consortiums into an interestbearing account until used; to monitor the actual cost ofthe work against the funds paid; to ensure that cost sharingarrangements were honored; and to standardize the auditclause.

We are currently looking at how 78 "other transactions"are being managed by the Army Communications and Electronics

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Command, Air Force Wright Laboratory, Defense AdvancedResearch Project Agency, and Defense Contract ManagementCommand. The current review found problems similar to thosein our 1997 report about the Defense Advanced ResearchProjects Agency. We have been cooperatively working withthe Department to make improvements in issuing andadministering the "other transactions" and correctingproblems identified. It is still too early to report on theresults from our other major initiative in this area, ajoint review with the Defense Contract Audit Agency on howthe contractors are charging costs to "other transactions."

The Department is operating and expanding this$3.8 billion program based on interim guidance memorandumsissued in 1994 by the Director, Defense Research andEngineering and 1996 by the Under Secretary of Defense forAcquisition and Technology. The Department needs to issuelong overdue official guidance on both the research andprototype "other transactions." In the early 1990s, the useof "other transactions" was restricted to the DefenseAdvanced Research Projects Agency and the lack of guidancewas not a critical problem since only eight contractingofficers at the Agency were involved. The small scope ofthe program permitted easy sharing of knowledge and lessonslearned. Since expansion of the use of the "othertransactions," we now have many personnel at multiplelocations trying to award and manage "other transactions."The lack of good guidance causes repetitive relearning ofproblems and solutions for managing "other transactions."The Director, Defense Procurement, recently promised toissue guidance and lessons learned within 120 days on use ofprototype "other transactions." The Director of DefenseResearch and Engineering has had draft guidance in processon research "other transactions" since 1994, but expects toissue it shortly.

The incentive for "other transactions" was to attractnew companies into doing research and development for theDepartment, yet the DoD collected no data on the program'ssuccess or lack of it in that area. We collected data forthe period 1990 through 1997 showing that 85 percent of thefunds for "other transactions" go to traditional DoDcontractors (81 percent) and nonprofit institutions likeuniversities, States and Federally Funded Research andDevelopment Centers (4 percent).

We noted that from FY 1990 through FY 1997, 170 newcontractors did business with DoD and this was only20 percent of the participants in consortiums working on"other transactions." The traditional DoD contractors andnonprofit institutions accounted for 669 of the participantsor 80 percent of the total. Some of the traditional DoDcontractors participated in as many as 20 "othertransactions."

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Program advocates may propose expansion of the "othertransactions" authority into production. We have expressedconcerns within the Department that, without performancemetrics on "other transactions," DoD and Congress cannotdetermine the benefits now and in the future of "othertransactions."

We are also concerned that if "other transactions"authority is extended to production runs of equipment, therewill be a need for additional scrutiny of pricing for sole-source items. In these cases, the Department will requireaccess to cost or pricing data, plus audit access for DCAA,in order to ensure fair prices. The Cost AccountingStandards should also apply, except perhaps in cases with anew commercial contractor that has no DoD contracts. Fornew contractors, the Department should have the authority towaive the Standards.

TESTING AND RISK MANAGEMENT

Adequate testing before buying or installing newsystems and adequate risk management have been basic tenetsof the DoD acquisition process for many years. We continueto believe that congressional insistence on independent testand evaluation was very prudent.

We recently reported that the Air Force planned toinstall Precision Landing System Receivers in 120 C-17aircraft with an estimated cost of up to $105 million.However, the Air Force was going to do so without sufficienttesting to determine if the system would work. Having seenthe inability to operationally deploy the existing MobileMicrowave Landing System on C-130 aircraft for the lastdecade, after spending $98 million, we had grave concernsabout the viability of this "streamlining" action. The AirForce also had not complied with several criticalacquisition management requirements, specifically,developing life-cycle cost estimates and assessing potentialalternatives to meet the requirement. In addition, the AirForce system was a command unique, service unique systemeven though the DoD objective is to develop a jointprecision approach and landing system for all Services. Inthe case of the C-17 Precision Landing System Receiver, wequestioned the risk assessment done by the Air Force. TheAir Force is now doing additional testing on the landingsystem before it installs the system on additional aircraft.

In implementing acquisition reform initiatives, theDepartment moves from a risk avoidance to a risk managementenvironment and the program managers are being asked toaccept bigger risks. However, in order to function in thisenvironment, the program managers and other acquisitionmanagers must make reasonable assessments of what the risk

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is and what actions can be taken to manage and mitigate therisk. We reported that risk management plans for the CombatService Support Control System, Minuteman III GuidanceReplacement Program, Fixed Distributed System, SingleChannel Anti-Jam Man-Portable Terminal, and the HunterUnmanned Aerial Vehicle were not adequate to identify,manage and reduce program cost, schedule, and performancerisks. A working group subsequently developed much improvedguidance on risk management. However, the Department needsto continuously assess and improve its risk identificationand management methodologies, techniques, and tools.

FOREIGN COMPARATIVE TESTING PROGRAM

We strongly support the expanded emphasis on using offthe shelf, nondevelopmental items. Similarly, cooperativeresearch and development with our allies often makes farmore sense than duplication, especially as many Defensebudgets shrink. We are issuing a series of audit reports onthe Foreign Comparative Testing Program, which provides fortesting foreign technologies and equipment that have thepotential to satisfy U.S. military requirements.

In one report, we recommended resubmission andreconsideration of testing the foreign-made nickel cadmiumbattery as a substitute for a silver zinc battery in theNavy SEAL Delivery System. By using the nickel cadmiumbattery for training and low-power mission requirements, theNavy can avoid costs of over $7 million annually and reducethe 30-year life cycle cost of the system by $166 million.The Navy agreed in principle and we are working with them toresolve details. In another report, we recommended stoppingfunding for an expendable countermeasures dispenser for theF-15, until the program manager could provide an executableplan to procure the dispenser if testing was successful.The testing of the dispenser was 20 percent of the $7.4million available for funding the testing program in FY1998. We are working with the program manager of theForeign Comparative Testing Program to further improve theprocesses used for planning and selecting projects fortesting. With improvements in the processes, the Departmentcan reap additional benefits from this program.

INTERNATIONAL COOPERATIVE RESEARCH AND DEVELOPMENT PROGRAMS

The Department has taken actions to improve the use ofInternational Cooperative Research and Development Programssince our 1992 report pointed out numerous weaknesses inthat effort, but a recent review showed that additionalactions were needed. The International Cooperative Researchand Development Programs are a family of programs in whichDoD and a foreign ally share in the cost and technologyadvances of research and development efforts. However,acquisition program managers are still not adequately

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considering international cooperative opportunities early inthe acquisition cycle. Out of 37 responses to aquestionnaire to 86 Acquisition Category I programs, over70 percent indicated little consideration given tocooperative opportunities. We will work with the Departmenton revising training and guidance to improve the use ofinternational cooperative research and development.

REQUIREMENTS DETERMINATION

While acquisition reform tends to focus on themechanics of development and procurement, significantsavings in those areas could be wasted if requirements areoverstated or misstated. In our audits, we have questionedthe reasonableness of the numbers of some weapon systems tobe procured and how the Military Departments determine thosenumbers. In many instances, the requirements estimatingprocess was little more than a multiplier of the number ofplatforms that can conceivably carry a particular system.

In a series of recently completed and on-going audits,we are assessing DoD theater models used in generatingquantitative requirements. Improvements have been made as aresult of the Capabilities-Based Munitions Requirementsprocess, which is intended to ensure that military plannersbase munitions requirements on the estimated number ofmunitions needed to defeat specified threats within a givenforce structure. The DoD has made considerable progress ingetting the Joint Staff and the Combatant Commands moreinvolved in these kinds of calculations. However, we areidentifying problems with the models used in the process.We are working with the multiple organizations responsiblefor the models to correct the problems. The Department mustmake hard assessments of what is really needed in light ofconstrained funding. Without a rigorous and realisticrequirements determination process, which recognizes thateach Military Department or each platform does not have to"kill" all the threats, the DoD will not be able toeffectively integrate the requirements estimating processwith the acquisition programs and budget.

ACQUIRING AUTOMATED INFORMATION SYSTEMS

The rapid advance of information technologies underliesthe ongoing revolution in both military arts and modernbusiness practices. For example, the use of modeling andsimulation is growing and will be used more and more inareas like training, testing and acquisition management.

The Congress addressed the compelling need to improvethe Government’s performance in managing informationtechnology programs by enacting the Clinger/Cohen Act. Weare attempting to provide thorough audit coverage of the keyissues confronting information systems acquisition managers.

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Those include: addressing the serious challenges posed bythe Year 2000 conversion program; improving the Department’sperilous computer security posture; moving away from decadesof disjointed information systems management to fullyintegrated systems; and effectively implementing thedisciplined investment decision making processes mandated bythe Clinger/Cohen Act. We have issued 43 reports on thesematters over the past 2 years.

We have found that, for major automated informationsystems, the DoD has not fully implemented the managementstructure and reform concepts envisioned by the DoDacquisition reform initiatives. In March 1996, DoD reissuedits "5000 series" of documents that address defenseacquisition policies and procedures. As part of theacquisition reform efforts, DoD integrated, for the firsttime, the acquisition policies and procedures for weaponsystems and information systems. However, we continue tohave concerns about the management controls for informationsystems. Recent audits have identified instances where themanagement controls for vital system development projectsdid not ensure adequate program definition, structure,design, contracting, assessment, decision reviews, andperiodic reporting. For example, we found that theacquisition of the Defense Civilian Personnel Data Systemneeded stronger acquisition management controls to includeclearly defined lines of responsibility, authority, andaccountability for the acquisition of the system; assignmentof a program manager with the requisite acquisitiontraining; and a comprehensive in-process review of thesystem to include the program acquisition strategy,acquisition program baseline, test and evaluation masterplan, life-cycle cost estimates, and information assuranceplan. The multi-component Defense Civilian Personnel DataSystem program life-cycle cost is about $10 billion, whichincludes $795 million for the regionalization/modernizationinvestment portion.

The DoD acquisition cost of automated trainingsimulator systems now exceeds $1.5 billion annually. Weperformed an audit that indicated the Department wasdeveloping and procuring large-scale (involvinginteroperable simulators, war games, and live ranges)information system training simulations without assigning asingle manager the responsibility and authority foroversight and coordination for these large-scale trainingsimulations. The programs lacked the visibility andacquisition oversight that are essential for investments ofthis magnitude and importance. The Department agreed andinstituted corrective actions.

In different reports, we have identified at least eightinformation systems, estimated to cost $2.7 billion, whichshould be subjected to Major Automated Information System

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Review Council milestone reviews. Information systems thatcost more than $30 million per year or $120 million in totaldevelopment costs or $360 million in life-cycle costs aresubject to review and oversight by the Council. TheMilitary Departments and Defense agencies do not alwaysidentify information systems as major and requiringmilestone reviews by the Council. The DoD relies heavily onaudits to identify issues like these; however, the declinein audit resources and hence, audit coverage, raises seriousconcerns regarding the adequacy of controls in this vitalarea. We understand that the Department will soon merge theDefense Acquisition Board and Major Automated InformationSystem Review Council processes. Because the DefenseAcquisition Board is generally considered a more rigorousoversight mechanism, we hope that such a realignment willmove the Department closer to full implementation of theClinger/Cohen Act and increased emphasis on automated systeminvestments. Time will tell.

SERVICE CONTRACTS

DoD service contracting is another high risk area forwaste and mismanagement. Service contracts is a growth areain DoD, and may continue to grow because of the expandedemphasis on outsourcing. About $93 billion was spent onservice contracts during FYs 1996 and 1997. The amounts forservice contracts annually exceed the amounts spent onprocurement contracts for weapon systems. For weapon systemcontracts, the senior leadership in the Department providesoversight through Selected Acquisition Reports, DefenseAcquisition Board reviews, and numerous briefings. Thereare almost no oversight mechanisms and the Office of theSecretary of Defense receives basically no information onhow the Department is doing in managing service contracts.We see no comprehensive efforts by the Department to overseeor manage the growth, costs, profits or fees for servicecontracts.

Since FY 1996, we have issued 44 reports coveringservice contracts. The majority of these audits resultedfrom Hotline allegations and congressional requests, ratherthan DoD management requests. The following sectionshighlight some of the service contract problems we found oncompetition, task order contracting, intra- and inter-agencyprocurements, and advisory and assistance services.

COMPETITION

Competition has long been the cornerstone for effectiveGovernment contracting. Competition has been an importanttool in ensuring fair prices and eliminating price scandalscaused by overpriced goods and services. Typically,competition results in price reductions of 5 to 30 percent.Competition works, but the process is dependent on the

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diligence of program and contracting officials to developgood acquisition planning, to publicize requirements, and toselect contractors who offer the best value and performanceto the Government. For service contracts in FYs 1996 and1997, about 72 percent ($66 billion) were awardedcompetitively and 28 percent ($26.4 billion) were awarded ona sole-source basis. For the 23 different categories ofservice contracts, the percent of competitive contractsrange from a high 92 percent for construction relatedservices ($12.1 billion) to only 48 percent for technicalservices ($2.6 billion).

I previously discussed specific problems with the twosole-source contracts for spare parts. DoD organizationsalso continue to miss opportunities to reap savings fromcompetition for services. Some contracting officers arewilling to accept faulty justifications for using other thanfull and open competition and work statements that give theincumbent contractor or a particular contractor acompetitive advantage, and ignore or circumvent thresholdsor procedural requirements. We continue to see instanceswhere contracting officers used incorrect justifications ofuniqueness or urgency when in fact, the real reasons wereinadequate planning or a desire by program offices tocontinue work with the same contractor or subcontractor.For example, in a recent audit of contract reconciliationservices performed by a major accounting firm, thecontractor was originally selected noncompetitively as asubcontractor to a disadvantaged small business firm.Subsequent awards were made to the accounting firm as aprime contractor, first as a lone competitor, then usingsole-source justifications of uniqueness of service andurgency. The award has stayed with the same contractorsince 1989, covering four time and materials contracts andthree contracting activities at a cost that has reachedalmost $80 million. In another instance, the Defense SupplyService-Washington planned to award a $45 million sole-source business process reengineering contract becauseprogram officials wanted to continue obtaining services fromthe particular contractor.

Contracting officers also avoided competition oncontracts set aside for small business by arbitrarilykeeping award amounts below thresholds at which competitionis required or using unrealistic minimum contract values todetermine whether threshold limitations were met. An auditshowed that Navy contracting officials inappropriatelyawarded 6 small business contracts noncompetitively becausethey used minimum contract values to avoid the thresholdsfor competing the contracts. Competition would have saved$45 million over 6 years on the contracts.TASK ORDER CONTRACTING

The Federal Acquisition Streamlining Act (FASA)

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authorized the use of task order contracts where thespecific content of the work to be performed is determinedafter the original contract is signed through individualtask or delivery orders for specific work to be performed.For contracts for advisory and assistance services where thecontract period exceeds 3 years and the contract amount isestimated to exceed $10 million, the Act requires, wheneverpractical, the use of multiple award task order contracts toallow quick, commercial-style competitions among theawardees when specific requirements are needed. We haveidentified use of large single-award omnibus contracts withbroad statements of work and no competition for individualtask orders. In these cases, the task order contracts wereawarded prior to FASA and work requirements have not beenrecompeted. For example, one Defense agency allowedcustomers to pick the desired contractor among the multipleaward contracts and direct work to that contractor withoutcompeting the requirement. On another multiple award taskorder contract, contracting officials competed the orders,but manipulated evaluations to select the preferred source,which was often the incumbent contractor on prior contractsfor similar work. The problems cited at the Defense agencyhave been resolved. At the request of Senator Carl Levin,we will be doing additional work this year on reviewing theuse of multiple award task order contracts.

INTRA-AGENCY AND INTER-AGENCY PROCUREMENTS

We have issued seven audit reports that havehighlighted persistent problems with use of inter-agency andintra-agency transactions. Although none of these reportsidentify widespread abuse like that found in the early1990’s involving Economy Act orders, the reports indicatethat some organizations continue either to use Economy Actorders to direct work to preferred sources or to avoidcompetition.

One report discusses a Navy program office that wantedto award a sole source $30 million small business contractthrough the use of an intra-agency order. Another auditindicated that the Defense Finance and Accounting Servicedirected work to a preferred contractor by adding therequirement to another Defense agency’s contract. In thisinstance, other contracts were available that could havesaved money from competition and lower management fees, butthe Defense Finance and Accounting Service would not havebeen able to ensure selection of the preferred source.Another audit identified the misuse of Economy Act orders bythe DoD Electronic Commerce Office, which was at the timepart of the Office of the Under Secretary of Defense forAcquisition and Technology. In that case, about $300,000was placed on an order to another activity solely to preventit from expiring.

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This area is difficult to control because there is noreporting system that provides visibility on whichactivities are ordering and accepting work or the magnitudeof Economy Act orders.

CONTRACTS FOR ADVISORY AND ASSISTANCE SERVICES

Contracts for advisory and assistance services, whichinclude most of the professional, administrative, andmanagement support services contracts and contracts forspecial studies and analyses, are an area where we continueto find problems. During fiscal years 1996 and 1997, therewere $18 billion of these contracts. Contracting officersare responsible for ensuring that contracts for theseservices are properly planned and administered. Agenciesare required to establish controls regarding the reportingof these contracts. In a recent audit, we determined thatthe Office of the Assistant Secretary of Defense (Nuclear,Chemical and Biological Defense Programs) providedGovernment facilities and equipment to a prime contractorand subcontractor without contracting officer approval oroffsets to reflect reduced costs in contract performance.DoD personnel also directed contractor employees andconsultants to perform unauthorized services valued at $15.7million, included tasks on one contract that involvedpotential conflicts of interest, and used contractoremployees on a prohibited personal services basis withoutthe contracting officer’s knowledge to compensate forstaffing reductions.

In summary, we recommend increased acquisition reformfocus on the services contracting area.

CONTRACTOR PENSION PLANS

Another facet of DoD acquisition that generallyreceives only limited attention is the overhead burdenassociated with contractor pension and insurance plans. In1997, we did a review to see if all recommendations in a1993 report on oversight of contractor insurance and pensionplans were implemented. Because of the significance ofpension-related issues in business combinations, the reviewfocused on contractors known to have acquired or soldbusiness segments. Billions of dollars of contractorpension fund assets accumulated from charges to Governmentcontracts continue to be exposed to undue risks.Specifically, Government-funded pension assets must beproperly allocated during restructuring to ensure futurecontracts do not bear a disproportionate share of pensioncosts. Based on estimated average pension costs of $216,000per employee, the pension fund assets, for the 15 largestcontractors, were estimated to be $100 billion. Weidentified six conditions that result in unacceptable reviewcoverage and substantial risk to the Government and found

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that incurred costs are improperly allocated to existingcontracts and forward pricing estimates for future contractsare inaccurate. The Director, Defense Procurement, and theDefense Logistics Agency agreed to take corrective action,which we will closely monitor.

DOWNSIZING OF ACQUISITION WORKFORCE

The acquisition workforce at DoD is undergoing a47-percent reduction from 617,000 personnel in 1989 to329,000 personnel in 2000. The Department is currentlyconsidering further revisions to the number and thedefinition of the acquisition workforce. Assuring thesuccess of acquisition reform efforts demands a leaner, moreprofessional, highly experienced, and trained acquisitionworkforce. Unfortunately, there has been no risk assessmentor systematic determination on whether needed processimprovement, such as electronic contracting, will occurbefore the personnel reductions are made. The GeneralAccounting Office has repeatedly reported that Defensecontract management is a high risk area. Nevertheless, bothcontracting staffs and audit resources have been drasticallyreduced, and further reductions are planned. At the sametime, DoD plans to increase the contracting out of numerousfunctions, thus creating more contract administrationworkload. The DoD also plans to increase its procurementbudgets significantly in the coming years, spending over$350 billion for fighter and attack aircraft alone. Bothtrends will increase the need for effective contract award,administration, and audit.

As DoD seeks to reengineer and streamline itscontracting processes, new business process techniques willbe key to accomplishing effective and efficient oversight inthe future. As we stated in a recent Semiannual Report toCongress, however, "Instead of workforce adjustments being alogical consequence of business process reengineering, thepersonnel reductions appear to have become a reform goal inand of themselves." Reductions to the acquisition workforceneed careful management instead of arbitrary accelerationbased on projected business process reengineering that isonly partially defined and may not occur.

Maintaining public support for Defense programsrequires good contract management and prompt identificationof any potential fraud. As personnel reductions in theacquisition workforce have occurred, we have also seenreductions in programs for fraud prevention, detection, andreporting. For example, I am very concerned about thedecrease in the number of fraud referrals that we receivefrom the Defense Logistics Agency. Since 1995, the numberof referrals for procurement cases has dropped by 47percent. This decrease is partly because the number ofpersonnel in the Office of General Counsel involved in fraud

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detection and referral at the Defense Logistics Agency hasbeen cut from 15 to 3. As reform efforts continue toemphasize partnering with industry, there also seems to beless emphasis at the working level on reporting potentialfraud. While we understand the many benefits of the newemphasis on Government/industry teamwork, the Departmentshould not assume that procurement fraud no longer occurs.To the contrary, our criminal investigators report thattheir proactive undercover efforts regularly revealsignificant fraudulent activity. Unfortunately, due toongoing downsizing, those proactive efforts are likely to becurtailed in the future and we are concerned that DoD fraudawareness and detection programs will be unable toadequately protect the many taxpayer dollars that fund DoDprocurement efforts.

PROCUREMENT FRAUD THREAT

A major focus of the Defense Criminal InvestigativeService (DCIS), the criminal investigative arm of the Officeof Inspector General, is procurement fraud. For FYs 1996and 1997, procurement fraud investigations led to472 criminal charges, 403 criminal convictions, 25 civilcharges, 22 civil judgments, 263 suspensions,321 debarments, and monetary outcomes of $465.7 million.

The following two product substitution cases illustratethe types of procurement fraud DCIS investigates.

Just last month, a company was indicted for allegedlyfalsifying quality assurance testing of high-reliabilitysemiconductors used in military and space applications. Thecompany allegedly falsified quality assurance testing anddata supplied to customers. The semiconductors are used inthe Army Commanche helicopter, the Navy F/A-18 fighteraircraft, A/V-8B Harrier aircraft, the space shuttle, spacestation Freedom and several military and commercialsatellites. The cost for rescreening, removing, andreplacing these semiconductors is $30 million for the AirForce, $10 million for the Navy, and $20 million for theNational Aeronautics and Space Administration.

In another case, the contractor under four separatecontracts delivered defective lifeboats to the Navy. Notonly did the lifeboats fail to meet contractualspecifications, but tests performed by the Federal Bureau ofInvestigations laboratory determined that the nonconforminglifeboats were dangerously unsafe when used for theirintended purpose. The loss to the Navy was $20.9 million,including $4 million to remove the unsafe lifeboats fromservice. The contractor pled guilty to one count ofconspiracy to defraud the United States and one count ofobstruction of justice and was sentenced to 5 yearsprobation. A civil settlement of $21.2 million was reached

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on charges of violations of the False Claims Act, breach ofcontract and unjust enrichment.

Many advocates of drastic changes in Governmentacquisition practices are unaware of, or choose to ignore,the fact that procurement fraud remains a threat to the DoDand the U.S. taxpayer. We must never convey the impressionthat we are becoming in any way tolerant of criminalactivity.

LEGISLATIVE PROPOSALS

My office has also sought to provide constructiveadvice in reviewing, commenting on and helping theDepartment draft hundreds of legislative proposals relatedto acquisition, logistics, and financial reform issues. Theother DoD components and we have not always agreed, but ourviews are always considered.

Today, I wanted to comment on two legislative issuesthat the Senate may consider this year or in the future:repeal of certain contract fee limitations and amendments tothe False Claims Act.

REPEAL OF FEE LIMITATIONS

The Department has proposed the Defense Reform Act of1998 to implement some of the recommendations in the DefenseReform Initiative Report. We are not opposed to most of theproposed Act; however, we disagree with a section thatproposes repeal of the fee limits on cost contracts.Specifically, the proposal would eliminate the 15-percentfee limit on cost-plus-fixed-fee (CPFF) contracts forexperimental, developmental, or research work, the 6-percentfee on CPFF contracts for architectural or engineering (A&E)services, and the 10-percent fee limit on any other types ofCPFF contracts.

We have disagreed with similar proposals over the last7 years. In FYs 1996 and 1997, there were about $4.1billion worth of A&E contracts. The fee limitations on A&Econtracts should be retained because the statute reasonablylimits how much the DoD can spend to design projects andprevents overspending on design efforts to the detriment ofactual construction. Critics claim that the low fees resultin A&E work that causes multiple design changes and contractmodifications during construction. We looked at 35completed military construction projects valued at $282million to see whether changes to contracts were neededbecause of inadequate A&E design work. We did not identifysuch problems. Critics also claim that fee limitsdiscourage competition, yet 84 percent of A&E contractawards had multiple bidders and we simply saw no proof ofthis contention.

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The fee limitations on CPFF contracts provide areasonable framework for the contracting officer to use innegotiating CPFF contracts and still allow flexibility toreward contractors according to different risk situations.Contractors have less financial risk on level-of-effort andcompletion type CPFF contracts than any of the othercontract types. Eliminating the statutory limitations onfees for CPFF contracts would likely result in varyinginterpretations by contracting officers and higher fees onsome CPFF contracts. In FYs 1996 and 1997, the DoD awardedabout $57 billion of cost-type contracts, of which about$29 billion were CPFF contracts. Also, contracting officersoften apply the 10 and 15 percent limitations as maximumfees on CPIF contracts (about $5.7 billion in FYs 1996 and1997) and cost-plus-award-fee contracts (about $25.7 billionin FYs 1996 and 1997). Thus, a lot of contracts will beaffected. For example, if the fee limit had been removedand contract fees had been increased by 1 percent, the DoDcosts for fee type contracts would have increased by about$570 million in 1996 and 1997.

FALSE CLAIMS ACT

Members of industry have recently suggested changes tothe False Claims Act, Section 3729-3733 of Title 31 UnitedStates Code. The Act has been an invaluable tool in thefight against fraud in government contracting and Ivigorously oppose proposals which would significantly raisethe required standard of proof and decrease the amount ofapplicable penalties involved in False Claims Act cases.

Some of those who have called for changes in the Actclaim that commercial contractors will not do business withthe Government because they fear that if they make a simplemistake and submit incorrect or erroneous documentation tothe Government they will be treated like criminals andaccused of defrauding the Government. They argue thatinnocent mistakes will unfairly subject them to thepenalties and treble damages available under the FalseClaims Act.

I note that we have seen no evidence of such misuse ofthe statute from those making these arguments. Secondly,their argument ignores the clear reading of the statute. Asimple mistake does not amount to a false claim subject tothe False Claims Act. The Act requires a knowing submissionof a false or fraudulent claim; the knowing use of a falserecord or statement to get a false or fraudulent claim paid;or a conspiracy to defraud the Government by knowinglygetting a false or fraudulent claim paid. Knowing andknowingly are specifically defined in the statute to requirethat a person, with respect to the information, (1) hasactual knowledge of the information, (2) acts in deliberate

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ignorance of the truth or falsity of the information, or (3)acts in reckless disregard of the truth or falsity of theinformation.

Proof of either deliberate ignorance or recklessdisregard of the truth requires far more than evidence of asimple mistake. In fact, such conduct is considered soserious and so difficult to prove that the courts have foundit sufficient when proven beyond a reasonable doubt, toestablish the "knowledge" required for criminal convictionsunder the felony provisions of the false statement statuteeven without proof of actual knowledge of the falsity of thestatement. Given that fact, Congress was clearly more thanjustified in providing lesser, civil penalties under theFalse Claims Act for similar conduct when proven by "apreponderance of the evidence," the normal standard of proofin civil cases.

Again, the False Claims Act has been essential to ourefforts to combat procurement fraud at DoD. According tothe Civil Division of the Department of Justice,$844,714,737 was collected during the last 5 years (FY93-97)as a result of DoD investigations of False Claims Actviolations.

BENEFITS OF DEFENSE CONTRACT AUDIT AGENCY

Along those same lines, I want to touch on severalother topics that relate to the future of governmentoversight efforts. I am concerned by the perceptions stillheld by some regarding the contributions of Governmentauditing of contracts in the new reform environment.

The Defense Contract Audit Agency (DCAA) is oftenunfairly criticized, especially by contractors, for notbeing in step with acquisition reform. In fact, they havebeen one of the leaders in reform in the Department, despitethe fact that they are being drastically downsized(44 percent and 3,150 positions between FY 1990 andFY 2002). To accommodate those cuts, DCAA has reduced thesize of Headquarters and regional offices, consolidatedfield audit offices, reduced the number of middle managementpositions, doubled the supervisory span-of-control, andsignificantly improved productivity. DCAA has supportednumerous acquisition reform initiatives and undertakensignificant business process reengineering in order toachieve this downsizing without negatively impacting itsmission. Notable efforts included significant improvementsin risk management, supporting Integrated Product Teams andthe Single Process Initiative, and leading reinventionlaboratories on oversight reduction and parametric costestimating.

Audits by the DCAA are one very important means of

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making sure we do not overpay for weapon systems. Over thelast three fiscal years, DCAA audits produced savings ofover $9 billion dollars. Last year alone, DCAA effortsproduced documented savings of $3.7 billion. In addition,each year contractors subject to DCAA audit do not claimreimbursement for over $2 billion in unallowable costs. Webelieve there is a clear correlation between contractors notclaiming things like "three martini lunches", "goldenparachute" payments, and tickets to sporting events or rockconcerts and the knowledge that claimed costs will beaudited.

There is some talk today about not obtaining costinformation under any circumstances; eliminating costprinciples, cost accounting standards, and contract audits;and even returning to the simple--but disastrous--1980’spractice of fixed price contracts for research anddevelopment. I support adopting reasonable commercialapproaches when there is a healthy competitive marketplace.However, when we are buying unique military weapons from afew dominant suppliers, we must recognize that we cannotnaively rely on competitive market forces that do not exist.In the absence of market forces, any prudent buyer, publicor private, would want objective verification that what ispaid is reasonable. In those circumstances, the Department,entrusted with billions in taxpayer dollars, has a clearobligation to act as an "informed consumer" to the greatestdegree possible. Blind faith reliance on a non-existentmarket would not likely produce the over $5 billion inannual benefits we now get because of DCAA audit work.

There are unique risks to both contractors and theGovernment when designing and producing complex and high-cost military weapon systems. This has been recognized fordecades. These risks necessitate certain safeguards.Recognition of those risks led Congress and policy makers toenact the Truth in Negotiations Act, to adopt flexibly-priced contracts, to promulgate cost principles, and todevelop cost accounting standards. In each instance,Congress required that auditing steps be employed in supportof these safeguard approaches. Auditing is, after all,simply verification. Prudent expenditure of public fundsrequires that where competitive forces can’t be trusted toyield a fair price, alternative protections must be employedand the results verified.

If anything, the risks may be greater today becausethere is such market dominance by a few very largesuppliers. In this environment, getting cost informationand maintaining audit rights is a prudent business practice.Failure to do so will be very costly for the Department andultimately the taxpayer.

BENEFITS OF THE TRUTH IN NEGOTIATIONS ACT

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The Truth in Negotiations Act, first tested in conceptduring World War II and then enacted into law in 1962, haslong proven to be a highly effective tool for assuring thereasonableness of weapon systems prices. I want to say afew positive words about the Act because it is oftencriticized, unfairly in my mind, by contractors and someother observers of Government acquisition practices. Duringconsiderations of the 1994 and 1996 acquisition law changes,the Truth in Negotiations Act was oftentimes used as anexample of outdated and unnecessary procedures. There was aconsensus that the Act needed some changes and it wasmodified and updated by the Congress in 1994 and 1996. TheAct is still serving the Department well, despite itscritics.

The Act’s cost and pricing data requirements only applyto high dollar value, negotiated procurements where thenormal pricing constraints of the competitive marketingplace do not produce adequate price competition. InFY 1997, about 53,000 contractual actions, valued at about$46.3 billion, were subject to the Truth in NegotiationsAct. The Act simply requires contractors to provide to thegovernment current, accurate, and complete cost and pricingdata - the same type of data that any efficient contractoris already generating for its internal price negotiationspurposes. It permits both the contractor and the governmentnegotiators to be in a position to negotiate fair andreasonable prices based on the same truthful pricing data.

We believe the Act has significantly reduced contractprices over the years, freeing up funds to help meet othercritical DoD readiness and weapon system procurement needs.The FY 1995 TASC/Coopers and Lybrand Study of ProcurementOversight Costs stated that the Truth in Negotiations Actincreases contract prices by 1.3 percent. The study onlyincluded ten contractors and can not be extrapolatedreasonably to all contracts. In response to the study, theDepartment looked at how the Act was being applied inregulations and actual processes, and subsequently initiatedprocedural changes and education to make its applicationless onerous and more efficient. A DoD process action teamalso did a review of the cost and benefits of the Act andreached quite different conclusions. They determined that,in FY 1994 alone, the Act provided $2 billion in benefitsand the benefits exceeded the costs by 267 percent.

Prior to this hearing, we updated the cost and benefitanalysis of the Act for FY 1997. We estimate that the Actcontributed to the identification of about $2.1 billion inbenefits, which exceeded both Government and contractorcosts by 310 percent. This is just the tip of the iceberg.Most cost savings from the Truth in Negotiations Act are

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achieved from the deterrent effect that encourages mostsole-source contractors to be open and fair. Because mostcontractors are complying with the Act and are providing theGovernment with current, accurate, and complete certifiedcost or pricing data, overall contract prices are being helddown to a lower level than they would be if the Act did notexist or were weakened.

We should not forget that commercial items have alwaysbeen effectively exempted from the Truth in NegotiationsAct. Fixed-price purchases of commercial items at marketprices do not carry the risks that the Act protects against.The recent statutory revisions to the Act ensure that theAct is employed only when the business risk justifies it.Further prohibitions could actually place the governmentbuyer at a disadvantage to the private sector in obtainingfair and reasonable prices. Many private sector companiesrecognize the importance of obtaining cost data and auditrights when confronted with sufficient pricing risk.

The push to eliminate the requirement for cost orpricing data by contractors is generally based on thepurported cost of preparing such data. It has been our longheld view that contractors do not have a legitimate argumentthat developing such data is too costly. All well managedcompanies employ cost accounting practices sufficient todetermine the cost of goods or services sold. Rather,contractors object to sharing that data with Governmentnegotiators since this deprives them of the advantage ofexclusive knowledge.

Making sure that contractors do not use superiorknowledge to make excessive profits is precisely whyCongress passed the Truth in Negotiations Act. The Actensures a "level playing field." Clearly, contractors havea responsibility to shareholders to make a profit, and theAct is not a law to prevent this. The Act helps ensure thecontractor makes a reasonable profit, not a windfall profitat taxpayers' expense. The recent experience on sparesprocurements, discussed earlier in this statement, hasdemonstrated that some contractors that have recentlyconverted from cost-based pricing to commercial pricing havesignificantly raised prices. While market-based pricing isstill justified in many of the cases, these experiencespoint out the need to move cautiously, especially in sole-source situations. This is particularly true today when wefind ourselves increasingly dependent on a few dominantsuppliers.

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REDUCTIONS IN THE OFFICE OF THE INSPECTOR GENERAL

Acquisition reform will not reach its full potential ifessential management controls are weakened to the pointwhere risk becomes unmanageable. As I have reported to theDoD and Congress on several occasions, including the lastthree IG semiannual reports to the Congress, I am veryconcerned that ongoing budget cuts are compromising theadequacy of audit and investigative coverage of DoD highrisk areas.

The Office of the Inspector General is being reducedfrom 1,620 workyears in FY 1995 to 1,059 workyears inFY 2001. The number of auditors is expected to be cut from619 in FY 1995 to 393 in FY 2001, and the number ofinvestigators is expected to decrease from 373 to 277. Toaccommodate that downsizing, the OIG has already undergonetwo reorganizations since 1995, eliminating administrativeinefficiencies and efforts in areas that while valuable, arenot essential to our statutory mission. We have been alsoattempting to offset those cuts through productivityimprovement. For example, our average time to performaudits decreased by 47 percent, the average cost per auditdecreased by 46 percent and the average time to prepare ourdraft reports decreased by 53 percent. We have also createdjoint planning teams with the Service Audit agencies inareas such as acquisition, logistics, and finance to improveplanning and eliminate any possible duplication and overlapin work.

Our audit workload is growing from required work drivenby the Chief Financial Officers Act, congressional requests,management requests, the Government Performance and ResultsAct, the Clinger/Cohen Act, Year 2000 Conversion, requiredaudits in the annual Authorization and Appropriation Acts,and reviews required under Office and Management BudgetCircular No. A-76 on contracting out Government functions.As mentioned earlier, we have also been working on numerousprocess action teams with Department managers and this is anew workload. We can no longer overcome increasing workloadwith productivity increases while continuing to downsize.If in 2001 you invite the Office of the Inspector General toa hearing such as the one today, we may not have much tocontribute, because audit teams covering acquisition matterswill likely be cut by up to 58 percent and procurement fraudinvestigators by up to a third.

Also, given the extent of the planned downsizing, wewill not be able to provide the prompt attention tocongressional requests we currently do. For investigations,we will be forced to focus resources on safety and readinessinvestigations and decrease attention to areas of highdollar crime such as procurement and health care fraud.

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Also, new but extremely critical areas such as computerincursion will not be adequately addressed. Given thevulnerability of DoD information systems, I believe it isessential to maintain a robust audit and investigativecapability in this area, but am concerned about ourcontinuing ability to do so. Resource cuts will require therealignment or closure of an additional one-fourth of ourinvestigations field offices, which will have a majornegative impact in some judicial districts. Our proactiveeffort on fraud prevention has already been curtailed andwill be eliminated if the cuts continue. Finally,investigative backlogs will grow.

Maintaining public support for Defense programsrequires good contract management and prompt identificationof potential fraud, waste or mismanagement in the process.Just the presence of auditors and investigators provides adeterrent to fraud, waste or mismanagement of contracts. Inmy opinion, inadequate investment in a sound audit andinvestigative effort compounds the problem and the dangersalready facing the DoD. This is an era of turbulence andconsiderable risk for the Department as it struggles withthe introduction of radically new processes, increasedstress on the workforce, reorganization, downsizing,increased reliance on automated systems, and conflictingpriorities. Despite the progress made by reforminitiatives, there are still many problems in theacquisition area and much work to be done. We believe soundand realistic management efforts constructively coupled witheffective and efficient oversight are essential to theDepartment’s ultimate success in this critical but verydifficult area.

Mr. Chairman, that concludes my prepared remarks. Iwould be happy to take any questions.